The Indian Rope Trick. - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
The Indian Rope Trick. A  A  A
3 APRIL 2008

It was a tale of two headlines.
The Indian newspapers reported that, for the 3 month period ending March 31st, the BSE-30 Index was down 23%. This was the worst on record since the time the Index data was compiled in 1979.
Meanwhile, the US newspapers reported that the US markets had their worst quarter in 5 years and the markets in the US were down 6%.

Table 1: The Indian rope trick
  Returns for the 3-months
ending March 31st (in US$)
BSE 30 Index -24.16%
MSCI World Index -9.46%
MSCI Emerging Markets Index -11.09%
Gold 9.09%

The last time I checked the US was the country in a recession, not India.
How come India performed this fabulous rope trick?
Why did the Indian stock market do worse than the US stock market?

While surfing the net a few days ago, I came across a survey on which asked the surfers whether the Indian economy is in a recession?
I clicked on "no" and was diverted to a page with the results.
There were some 2,600 responses at that time and approximately 60% of those had clicked on a "yes".
The "no" vote was some 35% and the other 5% were "not sure".

A recession is when there are 2 quarters of negative growth in the economy. Not a slowdown in growth (say, from a growth rate of 8.5% of GDP to 7.0% of GDP) but a negative number. For example, if growth is -3% in one quarter and then falls again by 2% then because we have two consecutive quarters of negative growth, we can say that the economy is in a recession. A reversal. A decline.

When growth rates are positive but lowered, then that is called a slow down.

But the 60% of the internet surfers who voted on were probably not aware of the difference between a slowdown and a recession.

Just like our policy makers who don’t seem to have a clue on the difference between short term money and long term money.

We have invited a (yet another) collapse of the Indian stock market by patting ourselves on the back every time a foreigner showed up at our door with a bag of cash.

We did not care whether the cash was here for the short term or the long term.
The colour of money is green.
A surging Index is better than a falling Index.
Even if it takes P-Note money brought in by speculators to cause that false surge.

So, the US is in a recession and most of its financial institutions are morally bankrupt and financially close to the edge.
Yet, Indian stock markets fall more than US stock markets?

Yes, because of an instrument called P-Notes.
The back door method for taking in gambling money from international gamblers.
You add that gambling money to our own local talent and you have a recipe for a spike and then a fall.
The international gamblers brought in USD 6 billion in 3 weeks in September/October 2007. The local punters added to their open positions.
The market surged.

The US economy and financial system was under threat.
The international gamblers went home. They have sold USD 3.3 billion worth of stock since January, 2008.
The local gamblers went bankrupt and there are fears that they will not pay their local brokers all their margin money and outstanding dues.

The Reserve Bank of India is our sanity.
They have strived to preserve the integrity of the financial markets by asking for a complete ban on P Notes since December 2003.
But no one listened.
And no one is still listening.

The RBI recognised the problem of playing host to gamblers.
India needs capital to build its economy for the next few decades.
Would any sensible housewife plan a savings pool for her child’s education based on what her husband earns at the gambling table?
Well, India did that.
We accepted short term money to build a long term economy.

And now the casino is empty.
The economy still needs to be built.

So, here is a suggestion to set the house in order.
Ban P-Notes completely.
Make it easier for long term international pools of capital to enter India: widen the FII door.
Tweak the tax system to encourage larger flows by local Indians, for the long term. I am not a tax expert but there can be ways to allow long term investors within India, to allow local Indians the opportunity to invest as much as they want to in stock markets via mutual funds. If these monies are kept in the funds for 5 years, the initial investment is to be treated as a tax deduction. However, if the money comes out before 5 years, put a penal tax rate of 40% on that initial corpus and on any gain.

India needs to do a better rope trick: one that harnesses long term pools of money to build for the long term economy. The rope trick we have concocted is a short term pool of gambling money that is now turned into a noose.

Gold has taken a bit of a beating since the middle of March and is now down some 12% from its peak. But here is a chart (since February 28, when the Quantum Gold Fund was listed) showing the 0.5% gain in the Quantum Gold Fund against the Quantum Long Term Equity Fund (-9.97%) and the BSE-30 Index (-12.20%).

Gold is a hedge, an umbrella for that very wet day. While I believe in the stock markets and certainly in the Quantum Long Term Equity Fund, there is a room for gold - just in case.

Table 1: Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold Fund Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

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